Viasat, Inc. (VSAT) Earnings Call Transcript & Summary

Good morning, everyone. Thank you, everyone, for joining us again on day 2 of Deutsche Bank's Virtual Space Summit. My name is Anthony Klarman. I cover the telecommunications cable and satellite space for Deutsche Bank here on the fixed income side, and I want to welcome everyone to this session with ViaSat. Joining with me on the conversation here today is the company's Co-Founder, Chairman and CEO, Mark Dankberg. Mark, I want to thank you very much for being with us here this morning.

Sure. Thanks for having me.

Absolutely. And for those of you who are online, you may see a free field text box below the video panel on your screen to ask to submit a question. If you have questions you would like me to raise during the Q&A, I'll do my best to kind of work them into the -- I can see the questions on my screen as they come through. But Mark, I thought maybe where we would start would be to just kind of level set everyone with sort of a few big events, a few big catalysts that are going on at the company. First, would be to kind of sort of walk back in time to the time of the announcement of the transaction with Inmarsat and kind of remind us of the views of management and the Board as it relates to the industrial logic of ViaSat SAW and Cs in the combination, the inherent synergy availability between the combination of the two companies and other markets that, that opens up and then we can talk a little bit about the phase of the transaction that you're in now with the CMA in the U.K.

Okay. Yes, we've been quite successful in the satellite broadband space. And one of the -- from a big picture perspective, there's a group of markets in mobility, that would be broadband mobility that we've really been successful and we see as a really good growth opportunity. So for us, especially the first one that we went into was in in-flight communications, especially with commercial airlines, and then also with business jets. But we see that broadband, global mobile market as being quite large. And it encompasses a number of other areas that we've not really business hadn't entered yet, mostly because of capacity limitations. And so those would include maritime and various ground robot applications as well. And then we also are in government broadband mobile applications. So as the -- as that market progressed, kind of what we had focused on, when we entered the broadband space about 10 years ago was really very high capacity, primarily through regional satellites. And that was kind of all the technology could enable at that time. The -- Inmarsat had taken an approach which was about global coverage, both use Ka-band, and they were about global coverage, both going after similar markets, but in different ways. Well, now what would happen in the intervening time is we're very successful in the regional market. I think our focus on having a lot of capacity and then attracting those airlines that saw connectivity as a good way to appeal to a broad set of passengers. That's been successful. And then the other thing that developed is that with ViaSat-3, we were able to take our very high-capacity satellites more globally. So we could have kind of that -- the combination of that global coverage value proposition and the depth of coverage value proposition. So Inmarsat has a large number of existing platforms, many more than we do, really good distribution. And they also have several satellites that do provide global coverage that kind of provide redundancy for ours and give us flexibility in how we use ours. So what we see is that -- and we kind of did the same thing when we entered the broadband residential market is by acquiring a company that had good distribution, a large number of existing customers that creates a really attractive outlet for our broadband transmission system and with the tools that we have to kind of optimize that for some of these markets like in-flight communications. So we think that what we'll do is allow us to grow faster and to address a broader scope of markets than we would be able to without -- this will give us a jump start in getting into some of these other markets. And the other thing that Inmarsat has, which is really complementary that we don't is what we call mobile satellite spectrum, mobile satellite frequencies, their L-Band service. And originally, L-Band -- maybe up until 10 years ago, L-Band was about as highest speed as you could get for a lot of these remote platforms. Now that's been eclipsed by what you're going to buy a Ka-band, but the L-Band is extremely robust to propagation impairments, especially rain. That's the biggest one. So that -- that's a really valuable, additional agreement -- additional capability that Inmarsat brings to us is the ability to bring both high speed and then high availability, where we can just use that L-Band in those particular places that -- where the wages are impaired by rain as an example. So that -- the net channel part of it -- and then what you need to do is go through the math, which is just how does this pencil out from an investor perspective? And how is it pencil out from a balance sheet perspective? And based on where they are, where their revenue and their earnings are, it's an accretive acquisition for us under the terms that we agreed to. And it also should accelerate our time to free cash flow. That was one of the other things about the acquisition that was attractive to us.

And we will get into some of the benefits that, that transaction brings you from an L-Band spectrum perspective when we talk a little bit about SATCOM and the smart phone.

Yes. Yes. That's another one.

Maybe sticking with the transaction for a bit. I sense a lot of people in this session are a lot more familiar with things like the DOJ and the FTC kind of regulatory review processes. They're less familiar with the competition and markets authority in the U.K. and the role that they play and kind of getting this transaction done. Can you maybe just update us all on the regulatory path to approval, the time line you would originally set out, how you think you can sort of work within that time line and what the competition authority in the U.K. is really focused on?

Okay. So just to start with, we originally anticipated a time line of about 12 to 18 months to complete the transaction. And a lot of that uncertainty is associated with the CMA in particular, because Inmarsat is a U.K. company, it operates in the U.K., we need their approval for this. The CMA has a two-step process in the first phase, which is completed now, really, their -- kind of their task is to determine if there's a reasonable possibility of what they call a substantial lessening of competition. So there, they do discovery around the two parties and they talked to. They did, I'd say, some background checking within the airline industry with competitors. And how do what they determined, which is a little bit surprising was that the existing competitors weren't really substantial and that there weren't many new competitors likely to interact within the time frame that they were considering. And that's pretty much what they wrote down. They said that buy side and Inmarsat were kind of the top two in the field and the other two -- the other competitors kind of dismissed. And so I'd say that was a little bit surprising, but it's part of -- but then what that does is it brings us into Phase II. And also at the end of that Phase I, what did they do and they and has been published as though write down what their findings are and the basis for those findings. So that -- I think what that reflects is that in-flight communications is a very complicated -- it's a very complicated business. And for them to assess that in a short period of time. I think there's quite a bit of new onset was left out. So in Phase II, really, what they do is they convene a new panel. They go through the same type of inquiries. But at the end, what their test is, is there -- is it more likely than not that there's substantial vesting of competition. So the hurdle is higher. And also they have more tools for discovery to really dig into this. So that's where we are. I think that if that process, what we think is the fact that would surface under that process, that the process could be completed as early as January or February. It's supposed to complete by March, which is within our time frame.

Any time frame of the original contemplated timing -- I think would it take you maybe all the way out to May, even in terms of your financing arrangements that you have lined up?

Yes. Yes. I mean that's -- I mean, it's conceivable that it -- they can continue to extend the process as opposed to reject this. What we think is given the facts and the hurdle, the difference in the hurdle further determination that we think there's a big chance that will terminate more towards the earlier side.

And I guess one of the questions that has come up has been in my limited interaction with CMA, although I've seen a few transactions that they reviewed, they oftentimes will also provide suggestions around remedy. And I guess how dissynergistic could potentially some of the remedies being -- have you guys looked at sort of what it would take to still have the deal be materially accretive for you given that they may be offering potential remedies that might create some dissynergy.

Okay. So one thing I didn't mention is one of the clear -- one of the things that they did define quite clearly in their Phase I is that the only part of the business that's at issue is aviation. So that -- and again, that was a little bit surprising because our aviation business is, I think, between the two companies, less than 10% of the combined business. So the scope is narrow, it's relatively narrow relative to the entire transaction. Right now, they did not suggest remedies. We haven't offered remedies. We think that just on the merits of will there be a substantial investment of competition based on this merger. I think the answer will be no, and we won't get to that. But yes, that hasn't come up yet.

Great. Thank you for all that detail. So one of the things that you announced after the transaction and much more recently was the sale of an existing -- the Link 16 business. And I guess you have sort of earmarked that towards kind of debt reduction, both on a stand-alone basis and on a pro forma basis with the combination -- the potential combination with Inmarsat. Can you talk a little bit about why that sale made sense for you? Obviously, the multiple seems very accretive to the broader pro forma combined enterprise value and how you think about what the makeup is of the government business that you have left and what the opportunities still are for you to pursue in government.

Yes. So that Link 16 business we created kind of from scratch over 20 years ago. It's a complex technology, it's used for -- it's an air superiority communication system, Data Link, mostly for air-to-air near the ground. There are -- there's -- there are really only two main players in it. There was us and a joint venture between -- called Data Link Solutions [indiscernible] British Aerospace. So -- and that business has grown. It's grown steadily. It's been nicely profitable. The issue is because of the way the program is managed, in it's been very steady growth, but it's not -- it's not our fastest-growing business. And then also, there is more and more integration of those data links with others. And so the synergy for us, one of the things that we're really focused on in our portfolio of products and services is synergy among them, especially among our government and commercial businesses. So that one was kind of a stand-alone business that is investments in it really did not have created a lot of value in our other space businesses and even not as much in our other defense businesses. So that was really the motivation behind segregating it out, plus it became evident that it was really, really valuable to other defense companies, probably more valuable on a go-forward basis to them than it would be to us. And that -- so that's what made sense to look at a divestiture for it. What that leaves us in our space business, in our Defense business, it's almost all the rest is around space and satellite. And what -- with the other portion being around cryptography and cybersecurity, including protecting space systems from cyber attacks. So those -- and that issue of out cyber attacks is certainly now becoming much more important in the commercial markets as well. So that still does have a lot of synergies for us. The -- I think that Link 16 business that we divested represented on the order of about 30%, 35% of our run rate revenue now. Now, it's been growing but not as fast as the rest of our businesses. And then what we're really aiming to focus on are more space services, which is especially true as we go global. And also, we've been doing -- we've won some really interesting awards in space relaying services, again, with -- from a government perspective. So that would be, for instance, relaying communications from low earth orbit satellites to higher satellites and then back to the ground for earth observation or communications and space-to-space communications. Those are all really interesting growth areas in DoD, and those we think represent good prospects for us to grow our government business a little faster than it has been. And then the other thing to having is with the Inmarsat transaction, that alone will get in our government business back up over $1 billion a year run rate. So we think it's -- especially now given the current capital markets environment, the ability to decrease our debt and our leverage that's really valuable right now. And we think it's going to end up focusing our business more on things that are more synergistic.

And just to make sure that I'm clear. So excluding Inmarsat, from the calculation, you would expect your government business to actually grow faster post divestiture, even if it's a smaller...

Yes, smaller -- it will be on a smaller base, but we think that the elements that are left will be as faster, faster growing than what -- the portion that we divested.

Great. So let's turn to some of the commercial opportunities. And obviously, a big one is IFC. You guys have a very good position in that market. You've announced some contract wins. I guess, maybe to frame the opportunity for the investors who are dialed in, can you talk a little bit about where the industry is broadly from a penetration perspective of true high-speed on airplanes. What do you think that number can get to in terms of market growth and -- and what ViaSat-3 kind of adds to the portfolio for you and being able to go after some of these higher-end IFC commercial uses.

Okay. Yes, I think kind of just as a couple -- just to frame the market, it's on the order of around 30,000 commercial airplanes or that number -- some we're taking out of service around COVID, but there's less of new deliveries. That number is expected -- has been expected to go up to around 40,000 by kind of the mid-2030s by both Boeing and Airbus. And the gross passenger account is about 3-ish billion a year. I mean -- and again, this is -- these are pre-COVID numbers that are coming back at different paces in different parts of the world. And look at sort of where it was about 3 billion airline passengers a year is expected to go to 4 billion. So that's a pretty significant market. Right now, people estimate that maybe around 7,000, 8,000 planes are connected. A lot of those have connections but don't have sufficiently high speeds to serve a large fraction of the passengers. So what -- kind of what we brought to the market where -- and we did this in the U.S. first, where we had our high-capacity satellites was the notion that well, everybody in the airplane wants to be connected. Historically, only 6% or 7% of people used in-flight WiFi. Some of that was because it was expensive or slow, or really only suited for business applications, primarily e-mail maybe some more light web browsing. What we believe, and this goes back 10 years ago, was that if there was sufficient bandwidth for everybody that you would engage almost everybody, the -- but it has to be under the right terms and price. And so that -- those are the issues that really what we're trying to address in order to really unleash that market. The -- in order to kind of consider what the potential is, I think what you need to do is consider the market really broadly, which is that having connectivity on the airplanes enables a lot of activities that otherwise wouldn't ever occur and that there's value to those as well. So kind of -- I think what we've talked about and others have is maybe a total revenue opportunity. That doesn't mean the passengers pay all that revenue or that the airlines pay that revenue that there's an opportunity for a company like ours in the $1 or $2 a month -- $1 or $2 per passenger per boarded passenger. And that's one of the ways to think about what that total revenue opportunity could be. And so that's -- but that's -- it's something of a journey to unlock all that. And -- but what it starts with is really good connectivity. And I think the other thing that we've been working with the airlines on is measuring what -- how do you measure whether or not you have good connectivity. And what are the really difficult things. At one point, there was focus on, what's the fastest speed you can get to a plane. And that is important, that's indicative of what you can do, but then the real issue is, well, how many planes are there in that area, how many planes are sharing that bandwidth. And what happens in hub airports like New York and Singapore or places like that. So those are some of the hard problems that we've been addressing, I think, quite successfully. I think that accounts for our success in the market in -- on a regional basis to date. The other thing I would add to that, though, is with the Inmarsat transaction, you can see what we're really aiming for is global mobile connectivity across multiple modes of transportation and applications. And what's really, really interesting is when you think about those issues about geographic concentration of demand, the cities, especially the coastal cities that are air hubs also tend to be shipping hubs. They may be rail hubs. So what really you can see is you can get a sense of what the opportunity is, if you can provide those types of connectivity, a lot of the connectivity value in airlines is really derived from the passengers and that can be us enabling things for the passengers, us helping the airlines enable specific capabilities or services for the passengers, other people that -- other services that people just use on their smart phones that otherwise aren't available. That's kind of the universe of what's possible there. We think it's really exciting, and we want to be able to apply that to all these different modes of transportation. So that's kind of -- we think it's a really big picture. We think we're off to a really good start.

Let me get into the revenue model a bit because I know this is obviously all going to be about monetization of these capabilities that you have and that you're getting with Inmarsat as well. Right now, the IFC model is a credit card swipe at the seatback of sort of getting it at your seat. But the airlines seem to be at least trying to pivot in the future towards kind of WiFi as a service on the plane where it's either embedded in ticket price or embedded in kind of the broader cost, like the pillow and the blanket and the bag of pretzels. What is it going to take to pivot to that? Because that would seem like when you force a customer to create a separate transaction, it probably suppresses some of the potential use cases. But sort of having it ubiquitously available probably gets adoption way up. What is it going to take to get the airlines to kind of pivot in that model? And is it really a function of waiting for folks like you and others to get to these next-gen technologies that can really ensure the user experience almost becomes terrestrial like in the use case.

Yes. So there are -- you've mentioned infection basically in terms of getting usage. And one of them is that -- is having the customer pay even $1, right? It requires some work and activity that really inhibits connectivity. So I think part of what's going on is our different efforts to make it seamless. That is -- so that passengers find themselves connected as easily as possible, even if they didn't realize they had switched from, say, their terrestrial connection to the in-flight connection. And the other one is the airlines. I mean, the airlines are super sophisticated. They're very complex operations. And what they're really looking for from in-flight connectivity is that it makes passenger satisfaction higher. And what they're looking for is that -- think of it as whatever money they invest in improving passenger satisfaction, yields the greatest amount of satisfaction for money invested. So they're trying to figure out how does that -- how does in-flight connectivity compared to a meal or a better meal, right? Or how does it compare to in-flight entertainment? Are people happier with curated content that they don't have to do anything about or are they happier just catching up on their own binge watching for services they already own. So there's a lot of questions that kind of need to be answered. And a lot of those questions can't be answered until the airlines are connected and trying these things. So different airlines are taking very different approaches to how they go about this. So we have some airline customers that make it free, and they're trying to get sponsorships, as an example, different forms of sponsorships. Other airlines may make in-flight connectivity free to certain classes of service or to certain -- of their frequent fires. They may use it to help promote other services. So I would say, right now, there's a lot of experimentation going on. But the end result, I think, is going to be that almost all the passengers end up using it in one -- to different extents for many different applications, and that they'll find that one way or another, which won't exclude passengers paying for some form of premium service. But I think that you want to see is very, very high proportions of passengers connected. The results that we've had, for instance, on airlines that make it free, often -- it's quite often you have more connected devices than people on the plane. And that's just indicative that there's demand there. Now what you need to do is just turn that into some monetizable form of customer satisfaction. And that can come in the form of a little bit higher ticket price that people are happy with. It's really relating passenger satisfaction to that connectivity. And I think the other thing that airlines are realizing is they don't get any points from passengers if they have a connectivity system on the plane, but people don't use it. They're very motivated to kind of erase that friction and get engagement because engagement, if it's good, that's what leads to customer satisfaction.

Understood. That's a great way to phrase it. This might be a good time. I'm cognizant of the time. It always goes much faster than I expect to pivot a bit towards the competitive question. You've bumped in to LEO in a few different places, and there's this big LEO versus GEO debate. To some extent, the Inmarsat transaction sort of doubles you down more on the GEO side. Can you talk a little bit about the GEO versus LEO debate? Kind of where you see LEO as having some complement to some of the things you do? And what you think some of the advantages are you are going to have over LEO, especially as they try to make inroads in consumer broadband in some areas where I think they're even running into some QOS issues in terms of the speeds that they can provide. Airlines, the same way. They're trying to make inroads into aviation. What role do you see them playing and what you think the inherent advantages are that you have?

Okay. Yes. So we think there's pluses and minuses of each. I think that most -- so the main disadvantage of GEOs is latency just because by definition, the only place where you can stay motionless or stationary relative to the earth is at that GEO amplitude. So that's what results in GEO latency. The big -- the flip side is that -- the analogy I use -- think of satellites don't do anything. Satellites are like a cell tower. It's the payload on the satellite that does something. So people shouldn't get hang up on the satellites. And then once you think about them as cell towers, the most obvious analogy is think about terrestrial wireless systems, where you would never see cell towers uniformly distribute it across, let's say, the United States, right? What you see is you'll see cell towers, lots to cell towers where the people are and not very many where there's almost where there's none where there's no people. So the biggest disadvantage with LEOs is that once you put them in orbit and they're moving with respect to the earth, you essentially have no control over the geographic distribution of your bandwidth, okay? And so that -- what that means is, especially as things scale that you end up with very large fractions of your satellites that are productive because they don't see demand. And if you go back to this issue that we just find, especially in the mobility business, where your customers are constantly moving around, what you end up with is a situation where you have these hotspots that -- so -- and I think that is exactly what happens in the cellular system is people will put layout coverage, and they look to see, okay, where is the highest demand? Because the failure mode is when demand exceeds supply at happy very notably when Apple came out with the iPhone in like places like San Francisco, service was horrible because the demand was so large. So what the cellular operators do is they tend to reinforce those places with higher demand. You can't do that if your satellites are going around the earth in a way that spreads their capacity. So that's the big advantage of GEO if you have -- think of it as -- a simple way to look at it is I think it's around 95% of the people in the world live on about 5% of the land. And when even if you think of mobility, where mobile platforms go between those places, they spend most of their time over the places where there's people. That's where all the journey is started in. So that's one of the really big advantages of GEO. The other one is that, by far, once you scale up the use of broadband by far, the most -- the thing that consumes those bandwidth is video streaming, which is not latency sensitive. So those two things create a big opportunity for us. We are working with non-GEO satellite systems. We think that's the way to both help reinforce some hotspots and also to get low latency for certain parts of traffic. Video gaming, interactive gaming is the biggest use of latency-sensitive applications. There's not very much of that on airplanes or these other transportation modes. So it's not as important right away. And then the other thing is I wouldn't really look at Inmarsat as doubling down on GEO. Essentially, what it does is it brings us distribution, the existing customer base that we can sell into. It brings us transmission, but we already have a lot of transmission. What their assets do is give us a little more flexibility and efficiency and using the transmission assets that we have. We are working on LEO systems. Partly, we're working on them through partnerships, but there's other -- there's some the technology that we did, I'm going to give you one more statistic. It's really important, okay, about the GEO versus LEO. So we launched, let's say, ViaSat-1, there's 100 gigabits satellite. ViaSat-2, there was a 400 gigabit satellite. ViaSat-3, it's going to be over 1,000 gigabit satellite. They're all the same size. So all of the improvement that we've gotten in throughput is due to integration of the payload. If you look at what's going on in LEO, it started with large numbers of small satellites, maybe 150 or 250 kilograms. Now you're seeing satellites that are 700, 800 kilograms, 2,000 kilograms, the latest one. And if you look at the cost of those satellites, mass is probably the best proxy for the construction cost of the satellite. So what's happening is in order to try to get more throughput and more efficiency, we've cut gigabits per megawatt, the satellites of getting a lot more expensive, much faster than they are at GEO. So those are the things that we like about GEO. What we like about LEO is latency reduction and a little bit of coverage.

Mark, I'm going to sneak one last question in because the clock is flashing at me, but we didn't talk about SATCOM and the smart phone. One of the things that Inmarsat would bring to you would be essentially mobile spectrum with the L-band, which has some unique characteristics that make that potentially a source of market opportunity. How far off is real kind of ubiquitous com and the smart phone and how important is the Inmarsat transaction is sort of enabling that as a future source of growth for you guys?

Okay. Well, if you look at the arrangement between Apple and Globalstar, that indicates that it's possible to do it with existing assets. Look, what happens is the speed that you can get to per phone or the capacity that you can get into an area is limited, so emergency services. I think that's possible to do with other transmission systems as well. Okay? But where people really want to go is e-mail, web browsing, messaging, that's going -- doing that at some scale or being able to use it, say, for emergency services were a large number of people in an area that's hit by hurricane or earthquake can all use it. At the same time, has to take new space, space assets, either some combination of GEO and LEO will work. And so that's probably realistic to be 3, 4 or 5 years off. Once you build -- if you build systems for that market, which is really enabled by making satellite capable modems in those smart phones, that's a really, really interesting market. And it's one of the things that we had in the back of our minds. We've been doing the Inmarsat transaction, but it wasn't -- at the time, it wasn't clear enough that we could factor it into our analytics on the benefits of the merger.

And that's maybe the important point that we can close on, which is future monetization opportunities, they are essentially incremental to the model that you underwrote for the transaction.

Yes. Yes. Yes. And we're hopeful that it could be really incremental. But right now, it's upside to what our plans were.

Well, that's great, Mark, as I knew it would. The time went really quickly, but very appreciative of you making the time to be with us here today. And I want to thank everyone for joining us for this session, and I'll be turning it over to my colleague, Edison Yu, for his panel coming up at 11:45 East Coast time. And I want to thank everyone for joining us for this conversation with Mark Dankberg of ViaSat. Thank you very much.

Thanks for having me. Bye.